Financial Planning magazine reported that its “perceived risk-tolerance level” barometer had dropped 7 points from January to 27.9 in February — the lowest level since its inception. This barometer seeks to measure clients’ (or self-directed investors’) appetite for risk. In looking at the readings over the last 12 months, it’s very easy to understand why emotions are the biggest enemy of successful investing. Let’s look at how well emotional reactions were able to time the market.
Two months out of the last 12 have had extremely low levels: September 2015 (28.9) and February 2016. What do these two months have in common? They were immediately after a month that had a sharp downward correction in stock prices. In other words, after a bad month, investors tend to want to sell out and/or change what they’re doing. The problem is that investors without a plan or those who give up on their plan are perpetually late. Care to guess what was the best month of 2015? October, up about 8.3% — a month emotional investors missed out on.
Investor emotions haven’t timed the market so well in 2016, either. As of March 18, the S&P 500 is up about 12% from its February lows, or 6% in the first 13 trading days of March. Basically, after the market corrects, people have less faith in the market.
So investors tend to feel pessimistic at the wrong time — but is their optimism more profitable? Unfortunately, the answer is “no.” For example, the reading was over 52 in December 2015, the 2nd highest reading in the last 12 months. That means people felt relatively good — but they were also wrong in their timing since both January and February had periods of sizeable pullbacks in stock prices.
What should you learn from this?
- Emotions are almost always wrong; they are the enemy of discipline. You’re probably hungry to chase more returns (and add risk) when you shouldn’t be, yet are looking for a place to hide when you should be coming out of hibernation.
- Emotions cause you to hunt for information that will support a decision you already want to make or interpret information you have in a manner that would support your emotional position. This gives you the illusion that your decision was based on logic when in reality it was deeply rooted in emotion. Psychologists call his “confirmation bias,” and if you are a frequent reader, you know I mention this a lot. Why? Because it’s that important.
- An investment plan should contain an understanding and acceptance of how the portfolio is likely to react in certain market conditions. In other words, the conversation about whether or not you’re taking the appropriate amount of risk should ideally be had when your confidence is high.
- Understand that the news media does not work for you or for me — ever. Seriously. Stop buying the emotion they are constantly selling.
If you aren’t sure your plan is set up to give you a chance to make meaningful progress toward your goals this year, or if you don’t have a plan at all, please give me a call to review your current investments and goals.
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